Eurozone: Growing despite headwinds Global Economic Outlook, Q4 2015

This summer’s events had the potential to derail the tepid recovery of the Eurozone, yet the recovery has continued. Its speed is still not overwhelming, but it has become more stable. Consumers remain the main driver of growth, while exports continue to be a driver despite emerging-market weakness.

This summer’s events had the potential to completely derail the tepid recovery the Eurozone has experienced since the end of last year. The Greek debt crisis escalated dramatically, with intense tension between Greece and its creditors. After a new bail-out package was agreed upon, equity markets in China plunged. This gave rise to fears about the Chinese economy, a crucial market for Eurozone exports.

The Eurozone has left the “stall-speed-phase” of the recovery behind, in which it was highly vulnerable to external turbulences.

Despite this very volatile, challenging environment, the Eurozone has continued its recovery. In fact, this may be seen as evidence that the recovery can now weather external shocks. In this way, the Eurozone has left the “stall-speed-phase” of the recovery behind, in which it was highly vulnerable to external turbulences. The speed of the recovery is still not overwhelming, but the recovery has become more stable.

Positive recovery trends

The Eurozone grew 0.4 percent in the second quarter, after 0.5 percent in the first quarter. Against the backdrop of weak economic performance over the last years, there is a clear, positive longer-term trend based on some encouraging factors (figure 1). First, the recovery now rests on a strong basis. All Eurozone economies, except stagnating France, grew in the second quarter. Second, there is a renewed growth dynamic in some countries. Spain experienced its highest quarterly growth since 2007, while the Italian economy grew in two consecutive quarters for the first time since 2011.

The growth drivers remained largely the same. Exports developed more than expected, driven by the devaluation of the euro. Also, private consumption further gained momentum, driven by somewhat lower rates of unemployment (figure 2) and low energy prices. Investment activity, however, remains weak and is still a drag on the recovery.

Early indicators also point in a positive direction. The Eurozone purchasing managers’ index in September stands at 53.9, solidly in positive territory (values over 50 signal expansion), pointing to further solid expansion in the coming quarters.1

Despite the generally positive trend, there are still significant differences between the four biggest Eurozone economies in the speed and depth of the recovery.

Despite the generally positive trend, there are still significant differences between the four biggest Eurozone economies in the speed and depth of the recovery.

Germany

While in the last quarters, Germany’s growth was mainly driven by domestic consumption—analysts already wondered whether Germany could become a consumer economy—this has changed, at least temporarily. While investment activity has still not recovered, currently it is again exports that drive growth, especially those to the United States.

In fact, the United States superseded France, which had the position of Germany’s most important export market for over half a century. In the first half of 2015, exports to the United States grew almost 24 percent.2 The reindustrialization of the United States, thanks to low energy costs, has been driving demand for German exports, particularly machine tools and equipment. The strong demand from the United States as well as the weak euro helped German exporters cope with weak world trade dynamics.

Nevertheless, it is unlikely that exports will continue to drive growth substantially in the coming quarters. The recovery will again become more consumer based. Consumer spending is likely to regain its dynamism, driven by continuing employment growth and rising wages. This will push up imports so that, on balance, exports are unlikely to contribute substantially to growth, as was the case earlier this year and last year. Overall, growth in 2015 is expected to be around 1.6 percent.3

France

France has been the exception to the general positive growth trend in the Eurozone. While starting strongly in 2015, it lost momentum in the second quarter and was the only country in the Eurozone that stagnated. This was mainly due to a decline in consumption growth, which previously drove the recovery. While in other countries such as Italy and Spain, the unemployment rate went down somewhat and therefore supported consumption, the unemployment rate in France slightly increased over the first seven months of 2015 to 10.4 percent. Also, early indicators such as the purchasing managers’ index show that business sentiment in France lags behind the Eurozone average.4

France has been the exception to the general positive growth trend in the Eurozone. While starting strongly in 2015, it lost momentum in the second quarter and was the only country in the Eurozone that stagnated.

While France’s growth, at a forecasted 1.2 percent, is very likely to lag behind the Eurozone average in 2015, there are some encouraging signs. French exports should profit from the weak euro as well as from the general recovery in the Eurozone. Growth dynamics will therefore depend strongly on a return of consumer spending and a positive trend in the labor market, while investment recovery is likely only in the later phases of the recovery.

Italy

Italy has left the recession behind, and its recovery has been gaining strength. In the second quarter, the Italian economy grew 0.3 percent, after growing 0.4 percent in the first quarter. The recovery is mainly based on private consumption and an improving labor market. In fact, private consumption saw its strongest growth in the last five years. Unemployment went down to 12 percent, which is the lowest rate in the last three years. Similar to the overall trend in the Eurozone, corporate investments in Italy remain subdued; investment actually fell in the second quarter.

A moderate recovery is the baseline scenario for Italy. Consumer sentiment is positive, so private consumption is likely to further drive growth, while the weak euro will help Italian exports. Moreover, the recovery of the Eurozone as a whole is set to support Italian exports. The growth rate for 2015 is likely to be around 0.7 percent.

Spain

The Spanish economy shows the most remarkable and impressive performance among the big Eurozone countries. In the second quarter, the economy had the strongest growth since 2007. The recovery is mainly based on strong domestic demand and exports, though investments in machinery and equipment have also been growing substantially. Consumption is supported by employment growth. In the last five quarters, employment grew by more than 900,000 jobs. While unemployment is still very high (22 percent), and many new jobs are temporary, Spain managed to achieve a strong reversal of the labor market.

The outlook for the Spanish economy remains positive, even if for the rest of the year the speed of the recovery is likely to somewhat decelerate. The recovery will be driven mainly by domestic demand in the short term. But even if the current dynamic decelerates, Spain is forecast to have, at 3.2 percent, by far the highest growth among the big Eurozone economies.

Outlook

The greater momentum of the recovery and its resilience against political and external turbulences are very good news for the Eurozone. Consumers remain the main driver of growth in the Eurozone, while exporters may compensate for the emerging-market weakness with greater exports to the Eurozone itself and to the United States. The big unknown going forward is the development of investments, which have been underwhelming since the recovery started. Corporates still seem unconvinced about the recovery or are hesitant in the face of various uncertainties within and outside the Eurozone. If their outlook changes, 2016 could give a decisive boost to the recovery. If not, the recovery is projected to remain at its current speed.